The performance of competing products can be measured in a variety of ways. One source of product performance ratings is provided by Consumer Reports. CR rates products on a 5-point scale that ranges from poor to excellent for different aspects of performance. We converted the overall performance scores to a zero to 100 scale. A score of 50 would be average. Scores above 50 would be above average on overall performance.

Figure 1 illustrates the product performance ratings for ten digital cameras along with their retail selling price. The ten digital cameras displayed in this table ranged 50 to 90, with an average of 72. Selling prices ranged from $130 to $300 with an average price of $206.

WHAT IS A FAIR PRICE?

FIGURE 2: FAIR PRICE LINE AND CUSTOMER VALUE

When these ten digital cameras are graphed based on performance and price we can see some obvious variance in the relationship, as shown in Figure 2. For example, the four digital cameras rated as 70 in performance vary in price from $130 to $230. The “Fair Price Line” in Figure 2 is a least-squares regression estimate of the relationship between price and performance. All Fair Price Lines run through the average of price and performance (shown in red). The Fair Price line represents what one would expect to pay for a digital camera based on performance. For example, the Canon A590 is priced at $180 with a performance rating of 80. The fair price based on the fair price line would be $223 for this level of performance.

WHAT IS CUSTOMER VALUE?

Customer value is the difference between a product’s fair price based on performance and its selling price. For example, the Canon A590 has a positive customer value of $43 as shown below:

The five digital cameras above the fair price line all have negative customer values as their selling prices exceed their fair price based on performance. The five digital cameras below the fair price line have a positive customer value that ranges $21 for the Pentax M50 to $71 for the Fuji. The fair price, selling price, and customer value is shown in Figure 3 for all ten digital cameras.

FIGURE 3: FAIR PRICE AND CUSTOMER VALUE

CUSTOMER VALUE AND PRICING

Digital cameras with a negative customer value are overpriced for their level of product performance.

Manufacturers have three options in an effort to improve customer value and offer a more competitive product:

Lower price while maintaining the current level of product performance

Improve product performance while maintaining the current selling price

Products on or near the fair value line are priced at or close to their fair price add little or no customer value. The three pricing strategies above apply to these manufacturers as well.

What about a product that offers too much customer value? While positive customer value is attractive for customers, it is not beneficial to shareholders. The margins for these products could be higher while still offering an attractive customer value. For example, the Fuji J10 has a performance rating of 70 and is selling at a price of $130. However, the fair price for the J10 is $201, providing positive customer value of $71. At a selling price of $149 the Fuji J10 would still provide a positive customer value of $52 as shown below:

This is still a very attractive customer value and the value provided is still higher than any of the other competing digital cameras. At a selling price of $149, the company is able to add $19 of profit margin to each digital camera sold. In this example, we would argue that the company underpriced their digital camera based on their performance and the price-performance of competing products. The goal in value pricing is to find a selling price the offers an attractive customer value and provides a good profit margin for the company.

EXPERIMENT WITH VALUE PRICING

You can find this example at www.MBM-Best.com under the Chapter 4 Marketing Performance Tools. All the data presented in this blog is provided in tool 4.2, Price-Performance Value Mapping. By changing the price and/or performance of any digital camera you can see how their fair price and customer value changes. This example is also presented in Chapter 4 of Market-Based Management, 6th edition on pages 132 to 134.

“To attract new and retain loyal customers, we launched a new and innovative boarding system, coupled with a business select product offering an improved Customer Airport Experience. We also strengthened our brand by refusing to “nickel and dime” our customers as our competitors have done. (1)

—Gary Kelly, CEO, Southwest Airlines

FIGURE 1: TOTAL COST OF A TICKET

The Airlines: What Are They Thinking?

One has to wonder what airline executives were thinking when they began eliminating in-flight service, charging for baggage, adding extra fees for flight changes, charging more to sit with a family member or associate, and adding an extra charge based on a customer’s size. These policies—and the anti-consumer attitude they convey—have driven the customer experience on most of the domestic airlines into the toilet, with one exception: Southwest Airlines.

Southwest strives to understand and enhance the customer experience, while offering pricing that provides a good economic value for its customers. The net result is a higher level of customer satisfaction, a lower rate of customer complaints, and a higher market share. Figure 1 illustrates the customer value that Southwest creates for a $69 ticket without add-on fees. The identical flight on a competing airline averages $146 for the same flight, when fees are added (2).

Airline Customer Complaints and Customer Satisfaction

In 2011, Southwest had the lowest consumer complaint rate out of 16 major airlines, while United Airlines had the highest complaint rate (3). Figure 2 shows the complaint rates for the top six airlines and a combined average of the other ten airlines (All Others). Five of the top six airlines had customer complaint rates that were higher than the average rate of the remaining ten airlines.

Figure 2 also shows the 2011 customer satisfaction scores as measured and reported by the American Customer Satisfaction Index (4). Southwest had the highest customer satisfaction score (81) and the lowest complaint rate. One can readily see that customer satisfaction scores decrease when the complaint rates increase. For this small sample the correlation was -.71.

FIGURE 2: AIRLINE CUSTOMER COMPLAINTS AND CUSTOMER SATISFACTION

But how does Southwest’s customer satisfaction compare to other top performers outside the airline industry?

FIGURE 3: SOUTHWEST AIRLINES BENCHMARK PERFORMANCE

Figure 3 provides a small snapshot of Southwest’s comparative performance within the industry, as well as a benchmark of the airlines against two other industries. While Southwest does not match Apple, it outperforms the PC industry average. When compared to personal care and cleaning products, Southwest is below the industry average. Serving an airline passenger, however, is a much more challenging customer experience than toilet bowl cleaner or deodorant.

Figure 4 examines the top and bottom performers in the American Customer Satisfaction Index database and presents a stock price index for these companies over 10 years (5). In this 10-year period, a stock index of 100 for the S&P 500 grew to approximately 200. The stock index for the top performers (Apple, Clorox, Southwest, etc.) grew to roughly 300. The stock index for the bottom performers was essentially flat after 10 years.

FIGURE 4: CUSTOMER SATISFACTION AND FINANCIAL PERFORMANCE

Southwest Airlines: Understanding the Customer Experience

In Southwest’s ongoing efforts to improve the Customer Experience, they contacted more than 10,000 randomly selected customers daily via e-mail to ask them about their recent travel experience with Southwest Airlines. It’s not surprising that their response rates exceed norms. Southwest’s customers are eager to share the purpose of their trips; disclose their willingness to recommend the airline to others; and to rank their check-in, gate, in-flight, arrival, and overall experience on a scale from one to ten (6).

Based on these survey results, Southwest calculates a Net Promoter Score (NPS)—the percentage of “Promoters” (those who are likely to recommend Southwest Airlines) less the percentage of “Detractors” (those who would not recommend Southwest). A high NPS indicates a strong competitive advantage. If customers indicate overall dissatisfaction, a score of one to six, they are asked to provide additional feedback as to why their experiences were less than satisfying. In 2011, Southwest airlines exceeded their goal of an NPS of 65 for the full year.

Survey results are published internally via the Southwest Customer Experience Dashboard, enabling employees to continually evaluate and improve their contribution to the overall customer experience. They are also able to drill down to specific locations and various aspects of the customer experience to better learn and target improvements. By improving the understanding of their customers through this survey, Southwest can identify successes and areas of improvement to keep customers coming back.

Net Promoter Score and Performance

FIGURE 5: CUSTOMER PROMOTION AND SALES GROWTH

The Net Promoter Score is a simple but valuable customer performance index. As shown in Figure 5, customers rate their likeliness to recommend products to others on a scale from zero (would not recommend) to 10 (would strongly recommend). Customers are then classified as Promoters, Passives or Detractors. The NPS is the percent of Promoters minus the percent of Detractors. Figure 5 also shows the Net Promoter scores for the top six airlines and its relationship to sales growth. Again, Southwest is in a league of their own with a score that compares to many other top performers such as Apple. One can clearly see that the NPS is connected to sales growth. The more customers are satisfied with their passenger experience, the more likely they are to recommend the airline to others. This creates word-of-mouth buzz that is free to Southwest Airlines. Likewise, detractors who have a bad customer experience and have low levels of customer satisfaction are more likely to tell others about their unfavorable experiences.

Customer Performance Metrics and Market Performance

A customer-oriented business such as Southwest Airlines is sensitive to the customer experience that they create. They track customer experience with metrics such as customer satisfaction, customer complaint rate and net promoter score—but also strive to understand what drives positive and negative customer experiences.

FIGURE 6: CUSTOMER AND MARKET PERFORMANCE

Figure 6 summarizes three customer performance metrics and two important market performance metrics. This clearly illustrates the relationship between customer performance and market performance, and demonstrates how Southwest outperforms their top five competitors. As the other airlines continue alienate customers with further reduction in services; additional fees; and higher ticket prices, Southwest should be able to continue to advance its level of competitive advantage and market performance.

Between 2007 and 2011, Apple’s sales grew from $24 billion (2007) to $108 billion (2011). This growth in sales is the equivalent of creating 12 average-sized Fortune 500 companies or creating a new company the size of Procter & Gamble ($82 billion in 2011). However, the astronomical growth in sales is only half of the Apple success story.

As shown in Figure 1, Apple’s gross profit as a percent of sales also grew from 34 percent in 2007 to 42.2 percent in 2011, due to the exploding growth on higher margin products such as the iPhone and iPad. Apple was also able to reduce it’s spending on marketing and sales from 9.3 percent in 2007 to 5.3 percent in 2011. This allowed marketing profits as a percent of sales (marketing ROS) to grow from 26 percent in 2007 to 37 percent in 2011.

Marketing profits are measured as net marketing contribution (NMC). Net marketing contribution is composed of three major components: sales, percent gross margin and marketing & sales expenses (M&SE). In 2011, Apple marketing strategies produced total sales of $108.3 billion. The percent gross margin was 42.2 percent and their investment in marketing and sales was $5.7 billion. As shown below, this produced a net marketing contribution of roughly $39.9 billion.

Marketing profits pay for all other expenses, interest and taxes, resulting in a net profit, as shown in Figure 2. The goal of marketing strategies should be to grow net marketing contribution, not simply sales. Also shown in Figure 2 is the relationship between Apple’s net marketing contribution and operating income (profit before interest and taxes) for the last 5 years. This is an incredible correlation and one not found in all companies.

Marketing Profitability – Ratio Metrics

In order to make comparisons between different companies, many financial metrics are expressed as ratio or percentage metrics. Financial metrics, such as return on sales, return on assets, return on equity and return on capital, are percentage metrics that help gauge the relative performance of a business. The same issue is relevant for comparing the marketing profitability across businesses, product lines, or markets that are drastically different in sales.

To make fair performance comparisons we have two marketing profitability ratio metrics. The first is marketing return on sales. As shown below, this is simply the net marketing contribution produced by a region, market, or company divided by its sales. Apple’s marketing ROS in 2011 was 27.5 percent.

Marketing ROI

A topic that seems to perplex many is how to measure the return on a marketing and sales investment. We have taken a financial approach, which is simply net marketing contribution divided by the investment in marketing and sales needed to produce that level of net marketing contribution. As shown below, in Apple’s marketing ROI was 701 percent in 2011.

Figure 3 examines the relationship between marketing ROI and operating income as a percent of sales for a sample of Fortune 500 companies. In general, companies with a higher marketing ROI have a higher pre-tax return on sales. As shown, Apple has steadily improved its marketing ROI as it improved its operating income as a percent of sales. The growth rate of Apple sales and profits may be difficult to sustain at the levels of the past 5 years, but we can expect their marketing ROS and marketing ROI to remain at levels that other companies can only dream of.